The FTSE 100 rise is 11% now after the market closed on the day of the famous referendum. But the pound’s value comparing to the dollar has dropped by 14%. Looking at the situation without the variables, we see the correlation between the events – the pound is losing its power.
This isn’t considered a reflection of the changes in the global trade situation, as most industries trade in dollars. This includes oil companies, mining and pharmaceutical corporations. Among them there are the Royal Dutch Shell and BP oil firms, as well as the leaders of pharmaceutics AstraZeneca and GlaxoSmithKline.
The rise of FTSE 100 may also be explained by the fact that 3/4 of all of the companies there earn most income from overseas. When the dollar gets higher in the rating, the companies get a plus in their values. There are reasons, though, why the pound’s fall, though helping to make Britain’s exporters more profitable on world markets, may be storing up trouble in the future.
It is pretty much impossible to find an equity analyst who believes that now is a time to sell UK equities. They have a vested interest in stocks continuing to rise, but by any historic measure the market looks expensive. The trailing price earnings multiple on which the FTSE 100 is selling, based on reported earnings rather than prospective ones, is about 19 times. This is well above its average of about 14 times in the past few years, even if it is well below the 27 seen in December 1999, before the tech stock bubble burst.
The market is yielding 4 per cent, based on forecast dividend payments. This may look attractive enough, but, given the continuing low interest rate outlook and the negligible returns available from gilts and bonds, there has been a shift in investors’ sentiment towards yield stocks.
There is no reason why this should not continue. Investors have to get value from somewhere and fund managers are stuffed with cash.
Some of the dividend yields have come well back from the silly figures seen in the immediate aftermath of the Brexit vote, when share prices in the housebuilding sector, a good payer of dividends after the long housing boom, fell sharply.
Some of the valuations at the time were, frankly, crazy. Shares in Legal & General were yielding about 8 per cent, which made no sense given the insurer’s strong financial position. The rise in the FTSE 100, and the recovery of the FTSE 250, which is more broadly based and more reflective of the domestic economy rather than global markets, has seen those yields fall back to more sensible levels.
The FTSE 250, which took an abrupt plunge after the Brexit vote because of that exposure to the British economy, has recovered, although a 5.8 per cent rise since the polls is less stellar than the soaring FTSE 100.
It is still quite easy to get a yield of 4 per cent or more on safe enough stocks, the utilities, for example, or specialised property funds that recycle rental income into dividends. This should continue to support equities.
Nevertheless, there is no question that the imponderables are still out there and that events could derail the market. Lower sterling will feed through eventually into higher inflation, which will mean that consumer-oriented UK stocks will suffer as they struggle to pass on those higher costs to cash-strapped consumers.
The bursting of the China bubble, the looming US election and the promise of greater protectionism there, a slowing global economy, the Italian banking crisis, the woes of Deutsche Bank and the uncertainty facing the UK as it struggles towards Brexit — all of these could undermine share prices.
Or it could be something entirely unexpected.
By any reasonable measure, the market looks overvalued and primed for a fall. For investors, stick to those safe income stocks. At least you are being paid well to face up to those risks.